Since we last checked in, there’s been a lot of developments in the world of finance. You may have heard that the stock markets crashed or lost a significant amount of value, and this may have caused some worry. Will we enter a recession? What does the movement of the stock market tell me about my personal finances? What even is the stock market?
These are all relevant questions that we’re going to try and answer in the next couple of weeks. But they all has to do with an even bigger question: what is investing and what does it mean for me? First we’ll explain what exactly the stock market is, and then we’ll break down all of the forms that investing can take and see how to decide what to get involved in.
So, for this week. What’s the stock market?
The phrase “the stock market” itself is the first misleading idea: there is no singular stock market. A market, as we all know, is a place where buyers and sellers come together to trade. A stock market is no different; it’s a place where sellers of stock and buyers of stock come together to trade. There are numerous stock markets - some of which you might have heard about, like the New York Stock Exchange (NYSE) and the NASDAQ.
When economists or business people refer to the stock market, what they mean is more so an aggregation of what is going on in the various stock markets around the world and online. It’s kind of like when we refer to the news; we want to know what media outlets are talking about in general, not just one in particular.
So, what is a “stock”? Stock, or equity, represents ownership of a company. If you own stock in a company, then you are entitled to a portion of that company equal to the portion of total stock that you own. Stock for public companies is measured in shares. A company is public if its shares can be openly traded, such as on an exchange like the NYSE - otherwise it is private.
If, for example, a company has given out a total of 10,000 shares in its lifetime, and you have bought and own a total of 100, then you own 100/10,000 or 1% of the company.
Why would you want to purchase stock? Well, this is where we can use our money to make more money.
Companies issue stock because they need cold hard cash to make purchases of their own, and they ask for cash from outside investors like you and me in exchange for ownership. Naturally, as the company grows and makes money, it can give some of what it makes back to its owners in a payment. We call this payment a dividend.
So, if I invest in Apple and I own 1% of its stock, and Apple decides to pay out $10 billion in dividends to its owners, I would get a $100 million payment.
A company’s dividend policy tries to be regular over its lifetime and should not significantly affect its growth in value; if a company decides to reinvest the money used for dividends instead of paying them out, for example, investors will see their stock price increase by the amount that expected dividends were supposed to be, essentially meaning that over the long-term, the payout for investors will be the same.
In a stock market, millions of investors and companies come together to offer up stock that they are trying to sell to investors that would like to purchase that stock. If a stock market crashes, that means that, in general, the value of stocks on that market have gone down because people don’t think they are good investments at the time.
Next time, we’ll talk about how to select what to invest in, and other types of investments beyond just stock or equity, such as bonds and real estate.